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Ans-1(a)
Economic Model:
(a) Its predictive power: means how closely it can predict the behaviour of the real
world situation without actually going into it (or experiencing it).
(b) The consistency and realism of its assumptions: if the model is very close to
the real situation it depicts, it is more accurate and consistent in its results.
(c) The extent of information it provides: A better model will provide more
information and that too, in details.
(d) Its generality, i.e., the range of cases to which it applies: A good model is more
general, i.e., it applies to more number of cases (or situations).
(e) Its simplicity: The basic purpose of the model is to achieve its objectives in
simplest possible way. A simple model is easy to understand and analyze.
Ans-1(b)
Macro Economics:
Definition: In Greek, the word ‘Makros’ means ‘large’. The word was coined in
1933 by Ragnar Frisch. The English word ‘Macro’ has been derived from the
Greek word ‘Makros’.
Prof. Gardner Ackely states that “Macro-economics concerns itself with such
variables as the aggregate volume of output of an economy, with the extent to
which its resources are employed, with the size of national income, with general
price level”.
This indicates that the scope of our analysis is not restricted to the investigation of
the total magnitudes of the economic variables, but their inter-relations too.
(iv) Extension of Public Sector in every economy and the resulting growing
importance of the role of government finance for growth, welfare and
stability.
Micro Economics:
Scope of Micro-economics:
Micro-economic analysis
Ans-2(a)
Demand of a product implies:
Px = Price of item x
Py = Price of substitute y of x
Pz = Price of complements
B = income of purchaser
V = miscellaneous factors
Statement of the law: “Other things being equal, the higher the price of a
commodity, the smaller is the quantity demanded and lower the price, higher is
the quantity demanded”.
Dx = f(Px), that is, the demand for x is a function of its price Px only.
Dx = a + b * P x
Demand Schedule:
It may be observed from the demand schedule that the price of x and its demand
move in opposite directions.
It the data of demand schedule is plotted graphically, it will look like that given in
the following figure. The slope of this curve is negative because of the inverse
relationship between Dx and Px.
Demand Curve
Demand Dx Linear (Demand Dx)
14
12
10
Demand Dx
8
6
4
2
0
0 2 4 6 8 10 12 14
Price Px
Ans-2(b)
Demand Analysis:
In simple terms, demand analysis seeks to identify and measure the forces that
determine sales. It reflects market conditions for the firm’s product. Once demand
analysis id done, alternative measures of creating, controlling and managing it can
be derived.
change in demand for the same price. Thus, in this case, if the demand
increases, we get a price-demand curve shifted towards right to the original
curve. In case of decrease, the curve shifts to the left of original curve.
Under homogenous oligopoly, sellers are few and products are identical,
business is transferable among rivals and the company’s own demand is
influenced by rival’s actions.
Ans-3(a)
Price Elasticity of Demand:
Market demand curves vary with regard to the sensitivity of quantity demanded to
price. For some goods, a small change in price results in a big change in quantity
demanded; for other goods, a big change in price may result in a very small
change in quantity demanded.
wQ P
K - u
wP Q
Suppose that a 1 percent reduction in the price of cotton shirt results in a 1.5
percent increase in the quantity demanded in our country. If so, the price elasticity
of demand for cotton shirts is 1.5. Convention dictates that we give the elasticity a
positive sign despite the fact that the change in price is negative and the change
in quantity demanded is positive.
The price elasticity of demand generally will vary from one point to another on a
demand curve. For instance, the price elasticity of demand may be higher when
price of cotton shirts is high than when it is low. Similarly, the price elasticity of
demand will vary from market to market. For example, India may have a different
price elasticity of demand for cotton shirts from United States.
The price elasticity of demand for a commodity must lie between zero and infinity.
If the price elasticity is zero, the demand curve is a vertical line; that is, the
quantity demanded is unaffected by price. If the price elasticity is infinite, the
demand curve is a horizontal line; that is, an unlimited amount can be sold at a
particular price. But nothing can be sold if the price is raised even slightly.
elasticity = f
15 Demand curve, price
Price (Rs) Æ
0
Quantity Æ
'Q 'P
Kp y
Q P
Quantity demanded at various Prices (small increment in price)
Price (in Rs. Per unit of commodity ) Quantity demanded (units)
99.95 20002
100.00 20000
100.05 19998
If we want to estimate the price elasticity of demand when the price is between
99.95 and 100.00, we obtain the following result:
For large changes in prices, this method is not accurate as the results vary a lot.
In that case we use Arc Elasticity of Demand method, which uses average values
of P and Q.
F
P1
G E
P2
Q
O Q1 D’
Q2
'P P1 P2 FG
'Q Q1 Q2 GE
P OP1
Q OQ1
GE Q1D ’ Q1D ’
GF Q1F OP1
Q1D ’ OP1 Q1D ’ QD’ FD ’
ep u 1
OP1 OQ1 OQ1 PF
1
FD
Given this graphical measurement of point elasticity, it is obvious that at the mid
point of a linear demand curve, ep=1, at point D, it is infinity and at D’, it is equal to
zero.
Ans-3(b)
Derivation of the Equation MR = d(TR) / dQ = q0 – 2 * q1 * Q
To its producers, the total amount of money spent on a product equals their total
revenue. Thus, to the Ford Motor Company, the total amount spent on its cars
(and other products) is its total revenue. Let us assume that the demand curve of
a firm is linear; that is,
P = q0 – q1 * Q
Where q0 is the intercept on the price axis, and q1 is the slope (in absolute terms),
as shown in the figure on next page. Thus the firm’s total revenue equals
TR =P*Q
= (q0 – q1 * Q) * Q
= q0 * Q – q1 * Q2
MR = d TR / dQ
= d(q0 * Q – q1 * Q2) / dQ
MR = q0 – 2 * q1 * Q
which is also shown in the figure. Comparing the marginal revenue curve with the
demand curve, we see that both have the same intercept on the vertical axis (this
intercept being q0), but the marginal revenue curve has a slope that, in absolute
terms, is twice that of the demand curve.
Price (P)
q0
MR = q0 – 2 * q1 * Q
P = q0 – q1 * Q
0 q0 / 2q1 Quantity
q0 / q1
demanded (Q)
Ans-4(a)
Techniques of Demand Forecasting
1. Expert’s Opinion Poll: In this method, the experts are requested to give
their opinion or feel on the particular product whose demand is under study.
Experts use their experience to predict the future sales. If the number of
experts is large and their experience based reactions are different, then an
average-sample or weighted value is found to forecast the sales.
If there are N consumers, each demanding Di, then the total demand forecast
¦D .
N
is i
i 1
Merits: The forecaster does not introduce any bias or value judgement of his
own.
Merits: This method is less tedious and less costly, and subject to les data
error.
Merits: This method simulates the market conditions, hence more accurate
than previous survey methods.
Limitations:
(i) The potential buyers may not take the things seriously.
1. Time Series Analysis or Trend Method: Under this method, the time series
data on the variable under forecast are used to fit a trend line or curve
either graphically or through statistical method of least squares. The trend
line is worked out by fitting a trend equation to time series data with aid of
an estimation method. The trend equation could take either a linear or any
kind of non-linear form. Some typical trend equations of demand
forecasting are :
Linear Trend: D = a + b * T
Merits: This method does not require the formal knowledge of economic theory
and market; it only needs time series data.
Limitations:
(iii) Sometimes, the time-series analysis may not reveal any kind of trend. In
that case, the moving average method or exponentially weighted moving
average method is used to smoothen the series.
(i) The leading series are data on the variables, which move up ahead of
some other series;
(ii) The coincident series make up or down behind some other series;
(iii) The lagging series move up or down behind some other series.
The barometric method has been used in some developed countries for
predicting business cycle situations.
Limitations:
(i) The leading indicator does not tell us anything about the magnitude of the
changes that can be expected in the lagging series, but only the direction of
change;
(iii) It may not be always possible to find out the leading, lagging or coincident
indicators of the variables for which a demand forecast is being attempted.
Merits:
(ii) Through this method, on can get both time-series data and cross-section
data.
Limitations:
(i) If the explanatory variables are not chosen realistically, they may be
misleading.
(iii) The regression method forecasts on the basis of past average relationship
and so, to the extent the future relationship deviates from past average, the
forecast will be wrong.
Merits: The forecaster needs to estimate the future values of only the
exogenous variables.
Limitations:
(i) This method assumes that the past statistical relationship will hold good in
the prediction period.
Ans-4(b)
Elasticity of Production
Ans-8(a)
Job Security Constraint
The three financial ratios are combined (subjectively by managers) into a single
parameter which is called the ‘financial security constraint’. This is exogenously
determined by the risk attitude of the top management.
A high value implies that the managers are risk takers, while a low value shows
that managers are risk avoiders.
Ans-8(b)
Fisher’s Quantity Theory
So in the Fisher Equation, the only reason for the demand of money , is that it can
facilitate the smooth conduct of transactions.
P *T
V
M
In Fisher analysis, V is assumed to be stable in the short period. Thus in a system
in which the output is at full employment level, given the short run stability of V,
the price level P will change in proportion to the supply of money, M.
Fisher laid excessive emphasis upon the fact that money acts only as the medium
of exchange and he could not clearly reconcile with the store of value function of
money.
Ans-8(c)
Social Cost Benefit Analysis
(a) the evaluation of investment proposals in terms of their estimated net impact
on the economy.
(b) It is tool for making investment decisions best suited to the development
strategy and objectives so that scarce resources contribute most towards the
national objective.
The initial step is to prepare a detailed project report. Based on this report, the
following steps are taken:
Ans-8(d)
Isoquants
Isoquants are geometric representation of the production function. The same level
of output can be produced by various combinations of factor inputs. Assuming
continuous variation in the possible combination of labour and capital, we can
draw a curve by plotting all these alternative combinations for a given level of
output. This curve which is the locus of all possible combinations is called
Isoquant or Iso-product curve.
Properties of Isoquants:
A(20,1)
B(10,3)
Q=Q3
C(6,5)
Q=Q2
D(2,10)
Q=Q1
LABOUR LABOUR
(1) each isoquant corresponds to a specific level of output and shows different
ways, all technologically efficient, of producing that quantity of output.
(2) The isoquants are downward sloping and convex to the origin. The slope of
an isoquant is significant because it indicates the rate at which factors K and
L can be substituted for each other while a constant level of output is
maintained.
(3) As we move away from origin, the output level corresponding to each
successive isoquant increases, as a higher level of output usually requires
greater amounts of the two inputs.
(4) Any two isoquants do not intersect each other as it is not possible to have two
output levels for a particular input combination.
Ans-8(e)
Ceteris Paribus
The Cost Function: both in short run and long run, total cost is a multivariable
function. That is, total cost is determined by many factors. Symbolically, we may
write the long-run function as:
C=f(X,T, Pf)
The clause Ceteris Paribus implies that all other factors which determine cost are
constant. If these factors do change, their effect on cost is shown graphically by a
shift of the cost curve. This is the reason why determinants of cost other than
output are called ‘Shift Factors’.
Any point on the cost curve shows the minimum cost at which a certain level of
output may be produced. This is the optimality by the points of a cost curve.